Over the past few years, the Chinese leadership has enacted many reforms in an attempt to transform China's economy into a more market-oriented consumption-based economy.
One of the recently enacted reforms allowed foreign retail investors to buy Chinese equities listed in Shanghai for the first time ever, by connecting Hong Kong's Hangseng with Shanghai's stock exchange.
Allowing foreigners to own Chinese stocks is a significant reform, as foreigners are less likely to be intimated by Chinese officials. If there is graft or corruption, foreign investors are more likely to talk about them openly in the media. In theory, this type of openness and transparency should improve the capital allocation going forward.
For many retail investors, China represents great promise. China has the largest population in the world, and its GDP has been growing at a healthy 7-8% annual rate for over 30 years. In recent years, China has also had many success stories, with a gaggle of Chinese tech companies such as Alibaba (NYSE:BABA), Tencent (OTCPK:TCEHY), and Xiaomi rising to the global stage. By being on the other side of the world, some Chinese stocks also offer the potential for uncorrelated diversification.
But there are downsides.
Many Chinese companies are not obligated to release their financial results in English, so unless Google Translate becomes orders of magnitudes better, many English speaking investors will be hard pressed to understand their Chinese investments.
Good returns are not guaranteed. Although Chinese stocks like Alibaba and Vipshop (NYSE:VIPS) may seem unstoppable right now, many Chinese stocks RTOs have let their investors down in 2011-2012. Also, while Chinese GDP has quintupled since 2001, the Shanghai Composite has remained flat.
Another negative is the decelerating Chinese economy. Even though China is officially growing at 7.3%, proxy data such as credit growth, rail traffic, and electricity usage suggest a slowdown. Historically stocks do not do well when economies decelerate and this time may not be any different.
With those things being said, I think China and Chinese stocks are a buy. The Chinese economy has come a long way from December 1978, and China's private sector is showing a lot of dynamism. Given that the private sector will play a bigger part of China going forward, market transparency should improve. China's economy may be weak now, but the reforms that the leadership enacted will eventually kick in. China has enough debt capacity to do a soft landing if needed and recessions are historically good buying opportunities for long term investors as well.
Personally, I don't think many American retail investors will actually buy Chinese stocks listed on the Shanghai composite (apart from taking advantage of the arbitrage opportunities). American investors already have enough Chinese investment choices, given the over 100 Chinese ADR's listed on the NYSE and NASDAQ. Furthermore, many American companies like GM and Las Vegas Sands already have a lot of Chinese exposure.
The move does offer a lot of opportunity to the 60 million overseas Chinese out there however, who can read and understand Chinese documents. I think the reform is a win-win for both China and retail investors everywhere.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.